Given the present state of institutional development of many developing countries' financial systems, these benefits could be substantial. Empirical evidence shows that increased competitiveness enhanced through financial sector openness spurs economic growth. Evidence also suggests that it is the number of foreign entrants in the market rather than their market share that has a positive effect on the functioning of national banking markets.
Increased competition may imply a reduction in domestic bank profits, but banking customers gain through reduced net interest margins, lower costs of fee-based services and the availability of a greater variety of services. Foreign and domestic financial institutions differ in their performance, interest and operational focus. Analysis suggests that reasons for foreign entry, as well as the competitive and regulatory conditions found abroad, differ significantly between developed and developing countries. The extent of the benefits of internationalization depends largely on how it is phased in with other types of financial reform, particularly domestic financial deregulation and capital account liberalization.
The experience of the European Union, in particular, shows that internationalization and domestic deregulation can be mutually reinforcing.
The degree of capital account liberalization can determine the potential gains and benefits of internationalization. Internationalization does not, however, require moving to a fully open capital account. Analysis suggests that internationalization of financial services results in less distorted and less volatile capital flows while also promoting financial sector stability.
Experience shows that it is vital to strengthen the supporting institutional framework in parallel with domestic deregulation and internationalization: this is particularly true of the regulatory and supervisory functions of the state but it also applies to the use of the market in disciplining financial institutions.
Both factors can play a crucial role in minimizing the potential risks of opening up, particularly when it comes to dealing with large non-performing loans. Multilateral agreements like GATS allow countries to add credibility to their plans for financial system liberalization. Tianyong Zhou. International Business in China. Lane Kelley. Diversity and Occasional Anarchy.
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